If you start working for yourself, you must register for Self Assessment with HM Revenue & Customs (HMRC) within the first three full months of self employment. Otherwise you may be liable to a penalty of £100.
Once you become self-employed, the tax rules are quite different from those that may have applied when you were an employee. Instead of tax and national insurance being deducted from your earnings under PAYE, you should be prepared to receive a bill at some time in the future. This can be an unwelcome surprise if you haven’t put enough money aside.
What profits do HMRC tax?
The starting point for the calculation of taxable profits is your profit and loss account. In calculating taxable profits you are entitled to claim deductions from your business income in respect of any expenses incurred for the purposes of running your trade. When you buy equipment or motor vehicles, you will be entitled to deduct a proportion of the cost each year you own them and use them in your business. Claims for such capital expenditure are known as capital allowances. There is currently a scheme called the Annual Investment Allowance that will enable 100% of the cost of certain assets to be deducted, subject to annual limits.
Tax is payable on the whole of the profits of a trade, and so payments for your own ‘wages’ (drawings) are not deductible. However, if your spouse works in the business, the wages are an allowable deduction, provided they are actually paid and are a reasonable reward for what is done.
How does HMRC allocate profit to tax years?
The aim of the system is that over the lifetime of your business the profits will be taxed in full, once, and once only. The general rule is that the tax for a particular tax year is based on the profits of the twelve months to your accounting date in that tax year. For example, the tax for 2011/12 – also known as the 2012 tax year – could be based on accounts for a year ending on various dates ranging from 6 April 2011 to 5 April 2012. There are various complications arising in the opening years, closing years and when the accounting date is changed.
What is due and when?
Tax returns covering income for the year ending 5 April 2012 have to be submitted to HMRC by 31 October 2012 if filed by paper return or 31 January 2013 if filed online. The return will include a self assessment of your liability to income tax and capital gains tax.
There are automatic penalties for late filing of tax returns.
Payment of tax
Tax due for the 2012 tax year will be payable by 31 January 2013. In addition, ‘payments on account’ of tax for the 2013 tax year may also be due on 31 January 2013 and 31 July 2013. See here for an explanation of payments on account. Interest and surcharges will be levied for late payment.
What about national insurance?
The self-employed are subject to a two-tier system of national insurance contributions. Class 2 contributions are at a flat rate of £2.65 per week, payable either monthly by direct debit or half yearly. Profits between £7,605 and £42,475 are subject to Class 4 contributions at a rate of 9%, and at 1% above that. Class 4 contributions are payable at the same time as the instalments of income tax.
Save for your tax
It is essential that you make proper provision to ensure the availability of funds to pay income tax and Class 4 national insurance. Interest on unpaid tax is chargeable by HMRC, and is not deductible from business profits. However, help may be available if you cannot pay your tax bills.
How we can help
We are available to offer advice regarding the various facets of self assessment.
Information in this Factsheet is correct at the time of compilation but is subject to changes in legislation. Information is of a general nature and you are advised to contact us to discuss your particular circumstances.